Avoid Trading ETFs Like SMH
There are times when a trader is looking at what ETFs to trade and all they hear about is how great the market is performing and traders get that FOMO (Fear of Missing Out) feeling. Traders seem to forget that right at the height of the FOMO there is huge risk for a turn to the downside. For this article we decided to focus on a real time example of the SMH (Semiconductors) ETF. We take a look at the SMH to help traders decide whether the time is right for a trade in SMH or whether traders should avoid trading etfs like SMH.
One of the hardest skills to learn as a trader is to step back and take a very big picture view of the market environment. Many traders get too caught up with the short term charts like a 15 minute chart or a 4 hour chart and even just a Daily chart. These time frames are important for open trades but in order to determine whether a trade should be opened requires a much larger view of the stock market first. What we try to answer here in this article is what methods can be used to make an informed decision as to buy the SMH now or whether a trader should avoid Trading ETFs like SMH.
Gain Big Picture Perspective on FOMO in the Markets
The stock market is a human behavior reflection of sentiment. This means that when traders/investors are feeling good about the economy and the stock market then they buy ETFs and stocks and you will see the stock market performing very well. On the flip side, if traders/investors are concerned or frightful about the market then no one wants to buy ETFs or stocks so prices go down. There is an index called the Fear & Greed Index that tries to measure how extreme Greed or Fear is in the market at a given point in time. You can see this index by clicking here: https://money.cnn.com/data/fear-and-greed/ and you can also see a snapshot of the Index below.
If you look at the right side you can see that 1 Year Ago the Index showed “GREED” at the 65 level and just 1 Month ago the level was at 86 which is Extreme Greed. Today it shows the market is Neutral so you can see that the market went from Extreme Greed 2 weeks ago to Neutral today. In terms of the big picture the stock market moved up in January and has continued higher up to today with Greed reaching Extreme in January.
Long Term Analysis using a Monthly Chart
So now we know what sentiment looked like last month and let’s now take a look at a Real time chart of the SMH (Semiconductors) ETF. We use TradingView.com for our charts as we have tried many other charting services but believe that TradingView has the best charting software. You can sign up to start using them here: TradingView.com
This is a MONTHLY Chart of the SMH and we have highlighted two different areas in the chart above showing how far above the price of the SMH is relative to the 200 Day Moving Average. The reason we are looking at price relative to the 200 DMA (200 day moving average) is to identify extreme market sentiment through price. For example, the farther price is above the 200 DMA then the probabilities of a sharp decline grow larger. Vice versa, the farther price goes below the 200 DMA the higher the probabilities of a move to the upside. We are only focusing on how far price is above the 200 DMA for this article. You can see that price is at an extreme level above the 200 DMA so on the longer term perspective the SMH is considered to be “Extremely Overbought” or to put it in perspective of Greed/Fear it is “Extreme Greed”. Certainly not the ideal time to be looking to open a trade expecting it to go substantially higher from here.
Confirming Your Bias to Buy/Sell/Hold
Taking a look at the same chart above but focusing on the lower part of the chart which shows our Proprietary Oscillator we use for confirmation. You can use many different indicators for confirmation such as the MACD, RSI, Moneyflow or hundreds of tools but for this analysis we are using our oscillator.
The Blue Dots represent our Oscillator and when the dots are at the upper end of the range as they are in this chart that means that the price has entered extreme overbought. We have gone back to 2011 and the highest level our Oscillator reached was .20 and you can see that we hit that level in early 2018 and currently the Oscillator is just above .18. This suggests that there is still a little bit of room left to the upside but most of the gains have been made already. What is next is a sharp reversal to the downside and it will happen in the blink of an eye.
Let’s summarize what we laid out here in terms of a methodology to use to determine whether you should Avoid Trading ETFs like SMH
The first step is understand whether the sentiment in the market is Greedy or Fearful and to what extent. We used the Fear/Greed Index to get a visual of the market sentiment.
The 2nd step is to look at a Monthly Chart of the ETF/Stock/Mutual Fund and see how far above or below the price is compared to the 200 DMA. We reviewed the SMH chart and noticed that price is extremely above the 200 dma.
The 3rd step is to use another indicator to confirm this overbought position. We used our own proprietary oscillator to confirm that price is at the high end of the range and that risk is rising substantially from here.
The Conclusion of the Process
Trading/Investing is not an easy task and you have to know when risk is high and low to determine how you can best position yourself to win. Extreme markets are the most tempting to participate in because sentiment leans too far to one side. We see that traders/investors in the SMH ETF are currently on the extreme greed scale and that means everyone is way to bullish for price to continue to rise. However, we’ve evaluated just how extreme this ETF is to the upside and is not worth the risk of entering a trade. In fact, what we’ve learned is that traders/investors should Avoid Trading ETFs like SMH at this moment in time as Extreme Greed will quickly turn into Extreme crying.